Opinion

The Great Debate

At least U.S. has Japan to fall back on

February 18, 2010

(James Saft is a Reuters columnist. The opinions expressed are his own)

The bad news for holders of U.S. debt, in case you missed it, is that China has sold so many Treasuries that it is no longer America’s leading lender.

The worse news is that there is a new creditor-in-chief, and it is Japan, an aging country with its own government debt bubble to contend with.

China sold about $34 billion of Treasuries in December, taking its holdings to $755 billion, while Japan increased its purchases and now is in the top spot of the Treasury Department’s scroll of merit, with $768 billion. China’s holdings peaked in April, since when the trend has been gently downward.

From a demographic point of view, though, the United States making a long term borrowing plan based on access to Japanese funding is a bit like my daughter making a retirement plan that has me continuing to work when she stops at its centre.

Japan is a wonderful country with many strengths, but one salient feature of Japan is that it is aging, or should that be aging, deeply in debt and dependent upon very low rates to continue to make those debts manageable.

Japan’s government debt to GDP ratio is 190 percent, as against 84 percent for the U.S. That huge debt, which has nearly quadrupled in the past 15 years, is made tenable because the Japanese are great savers and own the vast majority of their government’s stock of debts, unlike Americans, who own instead the vast majority of stuffed animals made in China. Japanese debt is also manageable because market interest rates are so low — just a 1.32 percent yield on 10-year government bonds.

Japan is getting old quickly and by 2020 will have an old age dependency ratio, the proportion of its population too old to work, approaching 50 percent. That will eventually spook global capital markets, driving up Japan’s borrowing costs. At the same time the overall call for capital in Japan will rise, both to fund consumption by retirees and, in one way or another, to service debt.

That makes Japan a real risk for the United States as a source of funding. They will have their own fish to fry and lending to the U.S. will be well down the priority list.

Japan’s growing stock of U.S. debt has to be viewed as temporary. This, in combination with questions about China’s strategy towards the United States and its debt, will throw a considerable shadow over the Treasury market for the foreseeable future.

CHINA’S STRATEGY
There are, to be fair, lots of reasons why China’s sale of Treasuries might not turn out to be that big of a deal. China may simply be rebalancing after it plunged heavily into U.S. short-term debt during the crisis, or the data may be hiding offshore purchases by China of Treasuries. And, to judge by action in the bond market, whatever selling China has been doing has not hurt the U.S.’s ability to fund itself at very cheap rates much at all. To top it off, there was strong overall global demand for U.S. assets.

There is also the fact that China and the United States need one another. Not only does China still depend upon U.S. consumption for its industrial base, it also, as a huge owner of Treasuries, stands to be among the biggest loser in any uncontrolled sell-off .

Still, and even with good will on both sides, the vendor financing arrangements between the U.S. and China cannot persist. Even as public debt spirals in the U.S. there is recognition that the economy had become too reliant on consumption and debt. China’s old and valued client will be a bit less valuable going forward.

Worries about China’s plans are not helped by calls by senior Chinese military officers last week to punish the U.S. for arms sales to Taiwan by selling some Treasuries in “retaliation.”

And China itself has criticized the dollar’s central role in the global economy and U.S. management of its own finances, raising suspicions that China, realizing that the good days are gone, is wondering how it can extricate itself from its central role in the Treasury market.

That extrication is likely to happen little by little rather than all of a sudden, but even so it will not take too much diversification by the Chinese to have a real impact on U.S. market interest rates.

Substantial and reliable long-term funding isn’t likely to come from Japan either, meaning that the best hope for Treasury investors lies not abroad but in the United States.

A bet on U.S. Treasuries then is a bet not just on the U.S. economy but on the U.S. political process.

(Editing by James Dalgleish)

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

Comments
5 comments so far | RSS Comments RSS

At least Japan earned a positive roll, and China was buying US treasuries to remain export competitive by keeping the value of the yuan down, but exactly what will American bond buyers get if they invest in long-term government bonds at what are historically low yields? A yield to maturity of 3.75% p.a. and marked to market losses if Japanese and Chinese buying does dry-up and real yields rise?

Posted by MrBill | Report as abusive
 

Seems like a geo-political credit crisis in the making…

Posted by tougar | Report as abusive
 

I doubt very much that Japan’s surprising T-bill purchases represent anything like ‘a bet on the US economy’. More likely, a huge amount of political pressure from the US was behind it, since Japan would have to be crazy to make that purchase on its own.

My guess is the US wanted partly to shore up the market and partly to let China know it isn’t the only player. Short-sighted on all counts.

As to China’s reductions, I think the money will go increasingly to purchases of real assets – minerals, oil, etc., and perhaps more direct investment in the US – to the extent the US doesn’t begin screaming about a Chinese invasion the way they did with Japan.

Posted by WatchingChina | Report as abusive
 

I strongly disagree with the statement that, “Substantial and reliable long-term funding isn’t likely to come from Japan either..” It all depends on what your definition of the long-term is of course, but I believe for the next 3-4 years or at least long enough to get us out of the current economic cycle, Japan will be a steady investor of US Treasuries. The key component to the Japanese economy is the cheap value of the yen to boost exports. With interest rates already at 0% to battle deflation, Japan has no choice but to buy US. You can’t write about Japan and US Treasuries and not mention currencies even once. Shame on you Mr. Saft.

Posted by stkenji | Report as abusive
 

This is really big. Perhaps 2010 will be the year when we will see the fall of modern Spain empire. To understand this you have to look to 16-17 century Spain and its overseas silver production. It may seem that the things are different now but in its essence the story is the same.
However in these times you need to prepare yourself mentally. You need to start growing peace in yourself in order to take advantage of these times we are living in.
My blog tells about it (see my webpage if interested in).

Posted by kordo | Report as abusive
 

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